Thoughts on Northrop Grumman's Relocation and Municipal Investments

Northrop Grumman (NYSE:NOC) is preparing to move its headquarters from southern California to the Washington area. In terms of direct employment, the shift will be small — a couple hundred new jobs joining the 21,000 already employed by the company in region. Here’s how the Biz Journal leads its story on the news:

The company broke the news in a news release Monday, saying it is considering locations in D.C., Maryland and Virginia. Northrop Grumman will complete the search by the spring of this year and open its new corporate office by the summer of 2011. It expects to base its decision on the amount of financial incentives offered by local jurisdictions.

Much of the rest of the piece is made up of quotes from officials from Fairfax, Arlington, and Montgomery counties and the District of Columbia, all saying how wonderful they’d be as locations for the firm and how they’re likely to pursue a deal. There’s an economic point to be made here, I suppose. To generalize a bit, when a firm makes a location decision like this, it will usually be because there is some gain to the firm to doing so. If there are positive agglomeration externalities involved in the destination urban economy, then the firm’s move will provide some benefits to other firms in the city, and other residents of the city. Some of that gain will accrue to the local governments, in the form of increased income and property tax revenues.

If a city has a unified government, then the surplus created by the firm’s move will be split between the firm, other businesses in the city, and the citizenry as a whole. The firm will move when it makes sense to do so, benefitting the local economy and increasing tax revenues.

But if the task of local governance is split between multiple jurisdictions, then the firm will move when it makes sense to move, and then it will be able to collect some additional portion of the surplus generated thanks to competition between the local governments. The destination city would be better off if the local governments could agree not to compete for the new arrival, and to adopt some sort of transfer payment to share the gains from the relocation — the “winning” jurisdiction could pay a higher share toward multi-jurisdictional infrastructure investments, for instance.

The failure to prevent this competition means that economic gain which would accrue to the metropolitan population, broadly speaking, is instead retained by the relocating firm.

Having said all that, I’m just wondering what the District thinks it may gain from offering incentives to firms like this. Property tax breaks are particularly costly for the city, given the many restrictions on land uses it faces (from public land ownership to the height limit). And there is no way for the District to ensure that employment will go to Washingtonians, rather than suburbanites who will pay their income taxes elsewhere. Lucky Virginia might end up with much of the income tax gain without having to shell out incentives.

The city would be better off spending the money on investments that improve quality of life in the District — among them, measures to make it easier to open small businesses, including retail and service firms people want but which are often constrained by foolish government policies (limits on uses, high property tax rates, and so on).

Sometimes, I get the sense that city leaders just don’t stop and think about what they’re doing. People are currently moving into the city by the thousands. Why is that? It certainly isn’t because the city has been using incentives to attract prestige headquarters.